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Without a U.S. recession, the Federal Reserve will be forced to raise rates higher than anticipated, bringing back all the bad parts of 2022 for investors, warned TS Lombard strategists.
While a consensus forecast of 5% for the fed-funds rate by the end of 2023 has emerged, TS Lombard researchers think a recession that forced the Fed to cut its benchmark rate to around 3%, appears more likely.
“The reason is that if the US economy ends up experiencing a recession in 2023, rates are going to be cut quite aggressively,” Andrea Cicione, head of research at TS Lombard, and Skylar Montgomery Koning, senior macro strategist, wrote in a Wednesday client note.
However, if the U.S. economy stays aloft, it also risks a “no landing” scenario, where the Fed is forced to raise rates into a more restrictive territory than currently anticipated, which would “prove treacherous for investors, bringing back the market conditions that prevailed throughout most of 2022,” they said.
This chart helps to visualize what a “no landing” scenario could look like, namely an economy that revs back up, which could boost corporate earnings, but with rising wages that also could squeeze margins, limiting profit upside.
What a ‘no landing’ scenario for the economy might look like
TS Lombard, Bloomberg
Stocks rallied to start 2023, partially on hopes that inflation appeared to be heading slowly lower, which gave bulls hope that it could spur the Fed to soon call it quits on additional rate hikes.
While the Nasdaq Composite Index
COMP,
was still up 8.7% on the year through Wednesday, the S&P 500
SPX,
was up only 2.9% and the Dow Jones Industrial Average
DJIA,
had given back all of its gains from earlier in the year, plus some, according to FactSet data.
Read: Why March could ‘make or break’ stock-market sentiment with 2023 rally at crossroads
This comes as Wednesday’s higher Treasury yields look attractive to investors, with the 2-year Treasury rate
TMUBMUSD02Y,
near 4.9%, its highest since 2007, and the 10-year yield
TMUBMUSD10Y,
touching 4%.
Even so, the TS Lombard team worries stubbornly high inflation could force the Fed to keep increasing rates, which could wallop stocks and erode the value of bonds, even those paying some of the highest yields in at least a decade.
“A bullish case for fixed income, on the other hand, seems more realistic — a recession is all that is needed,” they said.
Related: Why ‘dramatic’ rate repricing could leave stock market facing ‘fits and starts’ rest of year
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